What is a commodity? It is a raw material that the human being use to create the living well. Human use energy to drive machines, use metal to build weapons and daily needed articles and use agricultural products to feed themselves.
This energy, metals and agricultural products are 3 classes of commodities and they are essentially the building blocks of the global economy. Commodities are mainly used as an input in the production of other goods and services.
Commodities are traded in exchanges. In India MCX (Multi Commodity Exchange) is an exchange where bullion, base metals and energy commodities are traded. The major exchanges worldwide trades commodities futures.
What is a future contract? A future contract is a contract that controls a certain amount of physical commodities by inputting a deposit to access the contract. So for example, a standard futures contract of Crude Oil will control 1000 barrels of the crude oil commodity.
In the commodities market if we buy a futures contract are we buying it to take delivery? No, we are actually speculating on the price of the underlying commodity. We dont want all those barrels of Crude Oil, we just want to speculate on the future price of Crude Oil. Every futures contrat is a right to make or take delivery of the physical commodity. Because of that every contract has an expiry date and a first notice date. Because it is a contract traders generally ensure that they enter and exit prior to the expiration date otherwise he will end up in taking delivery of all those barrels OR kgs of the commodities.
The commodity markets are very well trending market and the price is impacted by the demand and supply across the planet.
Who trades the commodity markets?
Just as an example SOUTHWEST AIRLINES hedged or locked in 70% of their crude oil requirements at a price of $51 a barrel using futures contracts. Their competitors who were not hedged had to pay $120 a barrel.